Wednesday, August 31, 2011

Sentiment among euro-zone companies and consumers plunged in August, the latest sign that steep declines in equity markets earlier in the month, public anger over the second bailout of Greece and signs of feeble growth in Germany are taking a severe toll on the economic outlook.

The European Central Bank stepped into the fray again as the euro bloc's primary crisis responder, buying Italian and Spanish bonds ahead of a key sale of longer-term Italian government debt.

The Economic Sentiment Index fell for a sixth straight month, to 98.3 in August from 103.0 in July, the European Commission said, the weakest reading since May 2010. Economists had expected a smaller decline to 100.5.

The drop "resulted from a broad-based deterioration in sentiment across the sectors, with losses in confidence being particularly marked in services, retail trade and among consumers," the European Commission said in a statement.
More

Only a bit more than a month ago, the leaders of the euro zone were happily congratulating themselves on overcoming their differences and cobbling together a second bailout of troubled Greece. The package, which includes 109 billion euros ($157 billion) in fresh loans from an EU/IMF bailout fund, was supposed to rebuild investor confidence in the monetary union and alleviate mounting pressure on debt-heavy Greece. But it has done neither. The euro zone debt crisis intensified after the deal, turning up the heat on giants Spain and Italy. And now, bitter infighting within the zone threatens to derail the entire Greek bailout package. If the deal can't be rescued, the failure would deliver a blow that would sink Europe deeper into financial turmoil.

What's the problem? The continued disputes over the second bailout of Greece highlight just how difficult it will be for the euro zone to resolve the debt crisis and solidify its monetary union. The very structure of the union allows too many parties with too many conflicting interests to have too great an impact on policies that impact the future and stability of the entire euro zone. Until the leaders of Europe find some more efficient method of making and implementing decisions, it is hard to envision the euro zone ever escaping from its life-threatening trials.

The case of Finland best shows us how flawed governance in the zone really is. The government in Helsinki, which leans against continued European bailouts, agreed to the second Greek rescue on the condition that it receive collateral for renewed financial support. Subsequently, the Finns and the Greeks worked out a special side deal in which Athens would deposit a chunk of cash in an escrow account for Finland to ensure Helsinki's support for the bailout. (If that arrangement – Greece putting up cash to get more cash – doesn't make any sense to you, that's because it doesn't.) But that bilateral deal quickly fell apart. Germany opposed it, while other euro zone nations, including Austria and the Netherlands, understandably demanded the same privilege as Finland. The Finns won't back down on their demand, and euro zone finance ministries are still haggling over what to do.
More

Germany's neighbors and allies are growing increasingly concerned about Berlin's foreign policy direction. Some even fear that efforts to export its fiscal ideas could mean the prosperous country has lost sight of the European idea. Or worse yet, that it wants to dominate the currency union.

The euro has failed, though more politically than economically, according to an article in the September edition of US magazine Vanity Fair. "Conceived as a tool for integrating Germany into Europe, and preventing Germans from dominating others, it has become the opposite," financial journalist and author Michael Lewis writes. "For better or for worse, the Germans now own Europe."

The fact that a reunited Germany has weathered the Western world's financial crisis with ease, at least so far, has made its neighbors and friends uneasy. In the political salons of Washington and Paris, from Brussels to Madrid, and inside political broadsheets and think tanks, people are asking whether the new Germany is altering its foreign policy. Is Berlin turning away from the European Union, or is it the opposite, that it wants to use the currency to gain control of the entire continent -- something it couldn't do with weapons?

Geostrategists point to the emergence of a power imbalance, along with possible new conflicts between rival countries. In a guest commentary published by The New York Times last week, Former British Prime Minister Gordon Brown criticized Germany's approach. "Germany's recent failure to act from a position of strength endangers not only the country itself, but the entire euro project that Germany has spent decades developing," he wrote. Other commentators complain that Germany is once again veering towards unilateralism, and some, mainly in Britain, are even referring to a "Fourth Reich." But at the heart of this debate remains the question: Where is Germany headed?

In Washington, Chancellor Angela Merkel is seen as an uncertain ally. The Americans question whether she has truly left her East German past behind, or if she is rediscovering it -- at least in terms of Germany's interests. "Europe's Economic Powerhouse Drifts East," a headline in the The New York Times claimed in July.

Ultimately the euro crisis remains a pressure cooker building up steam despite the protestations of the currency system being saved by multiple political interventions. Yet after a half dozen supranational attempts to instil order within the sovereign nations of the EU, the markets are clearly not listening. Instead a market solution is now needed.

Many commentators have been suggesting a eurobond as the answer to Europe’s problems. However, given that Germany has so far rejected this option, the alternative needs to be a simple programme that rewards prudent debt levels, while providing a space for errant sovereign states to reorganise their finances.

The best solution would be the creation of two separate tiers of eurozone sovereign debt, senior and junior. The upper tranche would represent 30-60 per cent of the debt to gross domestic product limit in every nation. Given the high probability of all nations being able to service this debt tranche, these bonds ought to receive the triple A rating.

Given their voracious demand for secure fixed income, global investors would fund this at extremely low rates.

The German government is rejecting calls to allow the euro rescue fund, the EFSF, to bail out troubled banks directly. In doing so, Berlin is only deceiving itself -- and endangering the euro.

Start off by saying no. That, in a nutshell, seems to be the German government's policy when it comes to fighting the euro crisis -- one it has followed since the spring of 2010. Whether it was aid to Greece or to the expansion of the euro rescue fund, the European Financial Stability Facility (EFSF), Chancellor Angela Merkel always started out by taking a position contrary to economic and political necessity, only to end up caving in later. The approach has not been pretty to watch, and it also tended to exacerbate the crisis.

But the government has not, it would seem, learned its lesson. That can be seen by its contribution to the current debate over whether the rescue fund EFSF should be authorized help troubled banks directly in the future. Naturally, Berlin is rejecting this approach. But in so doing, it is deceiving itself on two counts. Firstly, it is behaving as if the banks were in excellent condition. And secondly, it is continuing to embrace the illusion that the euro can be saved without EU member states having to surrender any national competencies to Brussels.

Berlin's position stands in contradition to that of two institutions that know better. Both the International Monetary Fund (IMF) and the European Banking Authority (EBA) believe that European banks need more capital quickly in order to survive the current and future crises. The EBA is also calling for the EFSF rescue fund to take over this task and -- if necessary -- give the banks fresh money.

One can argue about whether it is wise to unsettle investors with such a public discussion, if one already considers the banks' position to be shaky. In terms of their proposals, however, the IMF's managing director Christine Lagarde and EBA head Andrea Enria are absolutely correct.

The list of Angela Merkel's critics is long these days, including many from within her own party. But even as she does what she can to ensure the passage of vital euro-zone reforms in late September, she risks alienating German voters. Her political life could be at stake.

Germany's Foreign Minister Guido Westerwelle's job is, for now, safe. His party, the Free Democrats, junior coalition partner in Chancellor Angela Merkel's government, has decided not to force him out of the cabinet.

Given the widespread critique of Westerwelle for his recent insistence that German sanctions played an important role in the toppling of Libyan strongman Moammar Gadhafi -- some of the sharpest having come from within the FDP -- his momentary political survival must come as a welcome respite.

It may also make his boss envious. It is, after all, the kind of reprieve which German Chancellor Angela Merkel will not have the luxury of enjoying any time soon. While Westerwelle is mired in mixed-messages about Libya, Merkel is up to her eyes in the euro crisis. And in Berlin, that crisis has reached a new phase recently.

Until now, the question had been primarily that of saving the common currency from collapse. Now, however, it looks as though Merkel's own political survival is increasingly tied to those efforts. Germans are becoming more and more tired of seeing their government pledge tens of billions of euros to assist heavily indebted members of the euro zone. And parliamentarians, particularly among Merkel's conservatives, have been listening. Should Merkel not be able to push through revisions to the European Financial Stability Facility (EFSF) -- agreed to at a European Union summit meeting in July -- through German parliament, her government, say Chancellery sources, could collapse.

The European high-yield bond market has been one of the success stories of the postcrisis economy, roughly doubling in size to €150 billion ($216.63 billion) since mid-2007. But August has seen a brutal selloff, hitting stronger credits and weaker borrowers alike. That should mean there is value on offer. But as long as the euro-zone sovereign-debt crisis remains unresolved, this is likely to remain a trade only for those willing to stomach more volatility.

The European market has been hard hit. In August alone, average euro-denominated junk bond prices have dropped to 87.4% of face value from 94.2%, while yield spreads over government debt widened 2.4 percentage points to 8.8 points, data from Barclays Capital shows. In the U.S. the yield gap is 7.3 points, 1.8 points wider in August.

Historian Hans-Joachim Voth gives the euro only another five years unless the euro zone is transformed into a full transfer union with massive redistribution. The continent is too culturally different to warrant a single currency, he says, adding that it would be best if Germany and other stronger economies left the euro zone.

SPIEGEL: Professor Voth, how much longer do you think the euro will survive?

Voth: Five years. The euro can't survive in its current form. We could, of course, make a full-fledged transfer union out of the euro-zone countries, complete with euro bonds and massive fiscal redistribution. In that case, we would have a different euro than the one that was originally conceived and promised to German voters. In the end, if the heads of state and government don't want that, it's likely that the euro will have to be dissolved.

SPIEGEL: Why can't the euro survive?

Voth: Even bad economic arrangements can be kept going for a long time. But the real questions are: Whom does that help? How long can one stand the pain? And what's the use? The euro can technically survive, but so can the never-ending attacks on the bond markets that are increasing the pain. But that just exacerbates the fundamental problem: that the main shock absorber has fallen away in the countries with very rigid labor markets …

SPIEGEL: … because these countries can no longer manipulate the values of their currencies to meet their individual needs.

Voth: Before, if Spain had gotten stuck in the kinds of difficulties it has today -- unit labor costs are too high, growth is too low, and there is enormous unemployment -- the peseta would have simply been devalued by 20 percent. In those days, Spain only had to change a single price -- that of its currency -- in order to make itself competitive again, and the market would generally help out as well. Cars could keep on being built in Pamplona and Seville. Houses on the Costa Brava were still affordable. There were no forced wage cuts in Spain, and prices remained stable. That's it.

Not only does this suggest default is now all but certain and will come soon, it also implies that the terms of the default will be particularly brutal for investors, with recovery rates possibly even lower than the currently anticipated 50%.

European governments are being forced to face up to the significance of a Greek default. This is perhaps the underlying message from International Monetary Fund Managing Director Christine Lagarde's warning that Europe's banks "need urgent recapitalization." She may have been warning about the costly alternative to a solution to the Greek sovereign crisis. But it could well be too late.

Finnish insistence on additional collateral against any further bailout loans it makes to Greece threatens to scupper Europe's rescue vehicle, the European Financial Stability Facility. Without EFSF funds, Greece will almost certainly have no choice but to default on its obligations.

German Chancellor Angela Merkel is weighing whether to yield to a demand by some lawmakers for a bigger voice in future debt bailouts as a condition to win her party's approval for a stronger euro-zone rescue fund, as a parliamentary vote on the issue was delayed a week.

Granting the German parliament the right to approve or reject future bailouts could trigger similar demands from parliaments across the euro zone, whose lawmakers are closely observing Berlin's actions. That could lead to further delays in the EU's approval for the Greek rescue.

The German vote on the European Financial Stability Facility was postponed Tuesday to Sept. 29 because some lawmakers want to participate in events surrounding Pope Benedict XVI's visit to Germany Sept. 22 to Sept. 25, said Michael Meister, deputy parliamentary leader of Ms. Merkel's Christian Democrats.

At issue is securing German parliamentary approval for a deal Ms. Merkel brokered with other European leaders in July to keep the debt crisis from spinning out of control. Conservative opponents of the deal worry it will open the door to relinquishing more sovereignty to the European Union.

Several models establish a positive association between public debt ratios and long-term real yields, but the empirical evidence is not always conclusive. We reconsider this issue, focusing in particular on possible spillover effects of large advanced economies’ debt levels to other economies’ borrowing yields, especially in emerging markets. We extend the existing literature by using real time expectations of fiscal and other macroeconomic variables for a large sample of advanced and emerging economies. We show that an increase in the public debt levels of large advanced economies - especially the United States - spills over to both emerging markets and other advanced economies’ long-term real yields and that this effect is significant at the current levels of advanced economies’ debt ratios.

In an unusual move, international accounting rule makers said some European banks haven't taken big-enough write-downs on the value of the distressed Greek government debt they hold.

Some banks are using their own models to value their Greek bonds and other distressed sovereign debt when accounting rules dictate that they should be using market prices to determine the securities' fair value, the International Accounting Standards Board said in a letter this month to the European Union's chief securities regulator.

In some cases, using the "mark to model" approach, as opposed to "mark to market," may have helped some banks to dodge potentially painful losses in recent midyear financial reports.

Tuesday, August 30, 2011

Transparency is a word that French banks find difficult to understand. At least, that is the view of global accounting regulators, who have stepped in to the row over how to value loans made to Greek banks. It is an important question because continental banks have loaned a large proportion of their spare cash to Greece, Spain, Portugal and Italy.

French banks, which still have a statist whiff about them after years as General de Gaulle's playthings, may have shied away from investment in American sub-prime mortgages, which the Germans lapped up, but they liked saying yes to debt-addicted Greeks.

They also liked to insure business transactions in Greece through credit default swaps. These derivatives provided hundreds of millions of euros in profit from sales during the good years, but are decidedly risky now that Greek businesses look vulnerable to collapse.
More

Summer-break has ended and we are back to offer you the best analyses and commentary on Greek Crisis.

In the following days a great number of selected op-eds and analyses are to be posted, so please keep up!

We wish to thank you for your continuing interest and support (reaching 163.000 visits!) and to urge you to continue visiting our blog, to read our posts but also to delve into the largest depository of opinions, analyses and news about the Greek Crisis (reaching 4.600 posts!)

We will always appreciate your comments and especially your suggestions for improvements, corrections, and most of all for anything important you believe we missed. Please send us your feedback.

A host of doubts still surround the second bailout for the country. The economy is in tatters, there is doubt over the bond swap at the heart of the deal, and a spat over collateral for Finnish loans is continuing. But while Greek bond yields have surged to fresh highs, with the yield to maturity on two-year notes at 46%, the rest of the euro-zone government-bond market hasn't taken fright. That marks a step forward in the crisis.

The Finnish collateral spat is another example of the euro zone's challenge in sorting out the detail for its crisis response and bringing all 17 member states together. It may yet become another deeply divisive problem, even though officials are working on a solution and Finland has said it can be flexible on the form of collateral.

Meanwhile, the news from Greece itself has been bad. The Finance Ministry now projects the economy will shrink 4.5%-5.3% in 2011, versus a prior forecast of 3.9%. The deficit may fall only to 8%-8.5% of GDP versus a target of 7.6%. And it isn't clear that the latest bailout will stave off an ultimate default, given that it doesn't reduce debt materially.

The International Accounting Standards Board has said European banks may have inflated their balance sheets and profit and loss accounts by not taking full writedowns on distressed Greek debt.

In a highly unusual intervention, the IASB on Tuesday published a letter from chairman Hans Hoogervorst to the European Securities and Markets Authority saying that some banks were using models to mark down the value of Greek assets, where market valuations existed.

When accounting for trading assets, banks are required under International Accounting Standard 39 to use arm's-length values taken from actual transaction prices to value the assets on their books. Where trading is very illiquid and market valuations cannot be obtained, they can then use valuation models using internal estimates of value.

In writing this blog, I have come across several facts about the Greek economy that surprised me. In some cases, it was the fact itself that was the surprise; in others, it was the magnitude of something I already knew about. Here they are, along with links to the relevant posts.

Fact #1. Greek GDP is at 2004 levels, and it will take about a decade to reach pre-crisis levels. Greece’s GDP has been declining since Q4 2008, and is now just above 2004 levels. What is more, the initial program agreed to with the troika forecasted that real GDP would not reach its pre-crisis level until the end of the decade. A greater than anticipated recession means it could take past 2020 for Greece to recover to the income level it had coming into this crisis.

Fact #2. Tourism export revenues have declined 28% since 2000. When analysts discuss how the Greek economy may grow, there is an inevitable emphasis on tourism. But tourism has been in steep decline in the last decade. In 2000, Greece’s tourism revenue was €10 bn (based on customs data). Ten years later, it had fallen to €9.6 bn, a 4.5% drop. But if we factor in inflation, revenues from tourism have dropped 28% since 2000, reflecting the structural flaws in Greece’s tourism industry, which relate, chiefly, to getting more tourists who spend less money.

Fact #3. Net exports from shipping have declined 27% since 2000. Shipping, Greece’s other major export, has performed better than tourism but only marginally so. In 2000, Greece’s revenues from shipping netted €4.6 billion. By 2010, that number had fallen to €4.5 bn. Adding inflation means that the drop has amounted to 27%, although some years were better than others. The chief problem is that from a trade perspective, shipping affects both sides of the equation due to money spent to buy ships and on shipping related services. When we take out the outflow of money, the net effect for Greece has been declining.

Slowly, word is getting round – even in Germany – that the financial crisis could destroy the European unification project in its entirety, because it demonstrates, quite relentlessly, the weaknesses of the eurozone and its construction. Those weaknesses are less financial or economic than political.

The Maastricht Treaty established a monetary union, but the political union that is an indispensable precondition for the common currency’s success remained a mere promise. The euro, and the countries that adopted it, are now paying the price. The eurozone now rests on the shaky basis of a confederation of states that are committed both to a monetary union and to retaining their fiscal sovereignty. At a time of crisis, that cannot work.

At the beginning of the crisis, in 2007-2008, the eurozone’s fundamental flaws could have been corrected had Germany been willing to support a joint European crisis response. But German officials preferred to maintain national primacy – and thus a confederational approach to Europe.

The head of Europe's banking watchdog has called for the euro rescue fund to provide direct aid to ailing banks to help calm markets. The head of the IMF made a similar demand, exposing an apparent rift with EU governments on how to handle the debt crisis. Berlin and the EU have rejected such changes.

The new powers of the euro bailout fund haven't even been signed off yet by the national parliaments, but there are already calls for its remit to be broadened, causing a fresh headache for Chancellor Angela Merkel.

The European Banking Authority, a supervisory body for banks in the European Union, wants the €440 billion ($635 billion) European Financial Stability Facility to provide direct capital injections to ailing banks. It is an attempt to reassure investors worried about the impact of the debt crisis on bank balance sheets, German business daily Financial Times Deutschland reported on Tuesday.

At present, the EFSF is only permitted to extend funds to individual countries, but those nations can pass the funds on to banks. Direct finance injections by the EFSF would speed up the process, and would in effect turn the fund into a stakeholder of the banks it helps.

The demand was made in a letter being sent by EBA chief Andrea Enria to the European finance and economy ministers this week, the newspaper reported.

The move is intended to help to calm markets after French and Italian banks suffered steep share price falls on worries about their financial health, prompting France, Italy, Spain and Belgium to impose short-selling bans on financial stocks. Pressure on European banks to raise more capital increased in July after European stress tests found that eight banks failed to meet capital requirements.

Enria's letter fuels pressure on euro-zone governments to do more to tackle the European debt crisis after the new head of the International Monetary Fund, Christine Lagarde, urged the EU on Saturday to force its banks to beef up their capital.

Miranda Xafa, a senior investment strategist at IJPartners and a former International Monetary Fund board member for Greece, discusses Alpha Bank SA's agreement to buy EFG Eurobank Ergasias SA and the outlook for a Greek rescue package. She speaks from Athens with Linzie Janis on Bloomberg Television's "Countdown."

Klaus Regling, the German CEO of the euro zone's bailout fund, the European Financial Stability Facility, is confident that the monetary union can overcome the current crisis. He considers the euro zone to be in a better position than the US when it comes to public debt, and accuses his fellow Germans of "hysteria."

The picture, a Balinese island landscape, is still leaning against the wall where it was a year ago. Back then, the European Financial Stability Facility (EFSF) had just recently been set up, and its chief executive officer, Germany's Klaus Regling, was too busy to hang the souvenir from Indonesia on the wall.

He is still just as busy today. Three European bailout packages later, it is clear that the EFSF and the European Stability Mechanism (ESM), which will succeed it in 2013, will have even more to do in the future. European heads of state and government recently decided to substantially upgrade both funds.

What is now taking shape at the EFSF's offices at 43, Avenue John F. Kennedy in Luxembourg City is the nucleus of a super-authority with which the 17 countries in the euro zone hope to save their currency. The amount of money it has at its disposal in the event of an emergency -- €440 billion ($634 billion) -- is three times as large as the entire European Union budget. The EFSF and the ESM will have a similarly important effect on the stability of the euro zone as the European Central Bank (ECB).

Monday, August 29, 2011

Having been an early supporter of the euro, I now consider my engagement to be the biggest professional mistake I ever made. But I do have a solution to the escalating crisis.

I have three reasons for my change of heart. First, politicians broke all promises of the Maastricht treaty. Not only was Greece let into the eurozone for political reasons, also the fundamental rule, “no member to exceed its yearly budget deficit by the equivalent of 3 per cent of gross domestic product”, was broken more than a hundred times. Mandatory punitive charges were never applied. To top it all: the “no bail-out” clause was wiped out in the wake of the first Greek rescue package.

Second, the “one-size-fits-all” euro has turned out to be a “one-size-fits-none” currency. With access to interest rates at much lower German levels, Greek politicians were able to pile up huge debts. The Bank of Spain watched the build-up of a real-estate bubble without being able to raise interest rates. Deprived of the ability to devalue, countries in the “south” lost their competitiveness.

Third, instead of uniting Europe, the euro increases friction. Students in Athens, the unemployed in Lisbon and protesters in Madrid not only complain about national austerity measures, they protest against Angela Merkel, the German chancellor. Moreover, the euro widens the rift between countries with the euro and those without. Of course Romania would love to join, but does anybody believe Britain or Sweden will find it attractive to join a “transfer union”? Meanwhile, dissatisfaction with the euro drags down the acceptance of the EU itself.

Václav Klaus, the president of the Czech Republic, spoke to friends of Hillsdale College in Berlin during Hillsdale’s 2011 cruise in the Baltic Sea. The speech was delivered at Berlin’s Hotel Adlon on June 11, 2011.

As some of you may know, this is not my first contact with Hillsdale College. I vividly remember my visit to Hillsdale more than ten years ago, in March 2000. The winter temperatures the evening I arrived, the sudden spring the next morning, and the summer the following day can’t be forgotten, at least for a Central European who lives—together with Antonio Vivaldi—in le quattro stagioni. My more important and long-lasting connection with Hillsdale is my regular and careful reading of Imprimis. I have always considered the texts published there very stimulating and persuasive.

The title of my previous speech at Hillsdale was “The Problems of Liberty in a Newly-Born Democracy and Market Economy.” At that time, we were only ten years after the fall of communism, and the topic was relevant. It is different now. Not only is communism over, our radical transition from communism to a free society is over, too. We face different challenges and see new dangers on the horizon. So let me say a few words about the continent of Europe today, which you’ve been visiting on your cruise.

You may like the old Europe—full of history, full of culture, full of decadence, full of fading beauty—and I do as well. But the political, social and economic developments here bother me. Unlike you, I am neither a visitor to Europe nor an uninvolved observer of it. I live here, and I do not see any reason to describe the current Europe in a propagandistic way, using rosy colors or glasses. Many of us in Europe are aware of the fact that it faces a serious problem, which is not a short- or medium-term business cycle-like phenomenon. Nor is it a consequence of the recent financial and economic crisis. This crisis only made it more visible. As an economist, I would call it a structural problem, which will not, by itself, wither away. We will not simply outgrow it, as some hope or believe.

Sunday, August 28, 2011

France and Germany may effectively run the European Union, but Finland has demonstrated how even a small country can disrupt their grand designs.

By insisting that it receive collateral from Greece in return for aid, Finland is threatening to upend an agreement that euro zone countries made in July to expand the European Union bailout fund.

That agreement is crucial to restoring confidence among bondholders that Europe can find a lasting solution to its sovereign debt troubles. But the continued squabbling in Europe has alarmed policy makers around the world, and the dispute over collateral provides one more measure of market uncertainty this week as the summer lull ends and trading regains a more normal volume.

The universal experience of financial crisis management is that the longer one waits to resolve it, the more expensive the ultimate bill will be. In the eurozone that moment has been reached. Two months ago, it was said the worst things that could happen were that the crisis would extend to Italy and Spain; and the economic recovery would stall.

Now the crisis has extended to Italy and Spain, and growth in the eurozone economy has slowed. The next plot point of the tragedy would be a return to recession. This is not a far-fetched scenario. Christine Lagarde, the International Monetary Fund’s managing director, warned with refreshing candour at the weekend that the risk of a recession was significant, and called for urgent policy action.

The crisis now has such force that it renders the existing resolution mechanisms defunct. The European financial stability facility was set up to handle small countries, such as Greece, Portugal and Ireland; it is useless as a mechanism to protect Italy or Spain. If you raised its lending ceiling to, say €2,000bn, France would stand to lose its triple A rating. That in turn would affect the EFSF’s own lending capacity, which equals the share of the triple A rated countries.

This was my first visit to South Korea and the instant reaction was pure astonishment. From Seoul, the imposing and enchanting metropolis, to Jeju Island, the magnificent tropical paradise, everything seemed so different from Western Europe and North America.

The differences with my country, Greece, were more than obvious: The high-rise buildings and the wide neat avenues circling ancient palaces in Seoul were so different from the identical and extremely ugly 6-story buildings and the streets congested by the numerous illegally-parked vehicles that embarrass the Acropolis.

However, after my first lecture, almost all my new Korean friends emphasized to me several times how many similarities there are between the two countries. Both were examples of rapid growth and economic development, of a rather successful westernization and of a steady alignment with the West during the Cold War. They were both marked by a ferocious civil war after WWII. Both countries have a tumultuous but steady liberal democratic politics achieved after years of autocratic regimes (Greece has more experience in democracy) with two major parties, one conservative and one social democratic, converging on welfare populism and government spending.

The fact that South Korea is one of the richest societies on earth, with steady economic growth, sound economic policies, good economic indicators and great achievements in industry, manufacturing, services, exports and tourism is not enough for them. The phantom of Greece frightens them as the Korean state is expanding and the same goes with their public debt ― which is only 33 percent of GDP now but is clearly on the path to reach higher numbers in the near future.

“I’ve never seen risk aversion this intense,” says the chief executive of a large European bank. “It is unsustainable.” His anxiety is understandable given the wild gyrations that rocked bond and commodity markets in early August and continued through the slow trading days of mid-August, when gold hit new highs and the yields on government bonds touched new lows in Britain and America.

Steep falls in stock prices this month have erased all the gains made over the past year. The hardest hit have been banks, with those in Europe getting the biggest clobbering. European bank shares have fallen by 25% this year, and have underperformed the wider markets and American bank stocks over the past two years. Banks in France are down by 33% since the start of 2011, those in Italy by 37%. Many banks now trade at a deep discount to the value of their assets. Barclays, for instance, has a market value that is less than half the worth of its assets. European banks are not unique in this regard. Bank of America, whose share price has slumped by almost half this year, is now valued at about one-third of its assets.

Friday, August 26, 2011

The world was expecting Eurobonds to come out of last week’s Franco-German summit; instead, the eurozone will get economic governance. According to German Chancellor Angela Merkel and French President Nicolas Sarkozy, the great leap forward to the creation of Eurobonds would perhaps be the culmination of that process, but for the moment small steps remain the order of the day. The question, obviously, is whether or not these small steps serve any purpose.

To answer this, we need to go back a little in time. Until this summer, the sovereign-debt crisis was confined to three small countries – Greece, Ireland and Portugal. Spain had succeeded in limiting the spread between its interest rates and those of Germany to about two percentage points.

By mid-July, however, the cost of borrowing for Spain and Italy was nearing four points, and France’s borrowing conditions were rapidly deteriorating. The specter of a full-blown crisis was starting to haunt markets. But the eurozone was not equipped to deal with this. The European Financial Stability Facility, established in 2010, had a lending capacity of a little more than €300 billion – ample for the peripheral countries, but too little to help even Spain alone. Disaster beckoned.

A program crafted only a month ago aimed at keeping Greece from defaulting on its bond payments is threatening to unravel because of a demand that the government post hundreds of millions of dollars in collateral for new emergency loans.

That demand has come from Finland, one of the European countries whose leaders proposed a rescue program for Greece, and has set off a series of similar requests from other euro-zone capitals that could jeopardize efforts to calm world markets.

The collateral issue is one of several stumbling blocks facing the program, announced by European leaders at a July 21 summit. Their agreement was designed to halt a nearly two-year-old crisis over government debt and financial stability in the 17-nation euro currency zone.

Since then the new Greek rescue program, which would be worth about $150 billion to the Athens government, has been under political attack in northern European countries where “bailout fatigue” is fast setting in. Efforts to include private investors in the rescue are struggling as well. While major banks agreed to accept a reduced value for their holdings of Greek bonds, the Greek finance ministry this week said it would scrap the program altogether if more private investors did not sign on.

Greece's worsening slump is threatening to compound another risk for the country: the steady withdrawal of money from Greek banks.

In the last 20 months, the country's banks have suffered an unprecedented withdrawal of customer deposits. Tens of thousands of Greeks—from the well-heeled to the less well-off—have moved their savings out of the country or stashed the cash in safe-deposit boxes or under a mattress, bankers say.

The consequence for many Greek banks is a growing shortage of liquidity that is increasing their reliance on emergency funding from the European Central Bank and forcing them to further cut lending to businesses. That, in turn, is deepening Greece's recession, making it harder for the government to narrow its gaping budget deficit.

Speculation that the government might default on its debt, pushing the banking system into insolvency, is fueling such withdrawals. In addition, many Greek households, under financial pressure, simply need their cash reserves to make ends meet.

Economists say there are signs that bank deposits have stabilized in recent weeks, following the latest European bailout deal for Greece reached in July. But amid a worsening economic outlook, analysts say they doubt the calm will last.

When Europe's leaders return from their summer break next week, they'll find plenty of work waiting. And, once again, little time in which to do it.

The European Central Bank held back a destabilizing rout that flickered earlier this month in Italian and Spanish government bonds, by continually buying them on the secondary market. But that, as a top ECB official said in a magazine interview this week, is "not a permanent structure."

It will be up to euro-zone politicians to build one. Their pre-vacation summit on July 21 laid a few bricks, but the rest exists just as conceptual drawings.

Euro-zone policy makers on Thursday appeared no nearer to settling a dispute over Finland's collateral demands in exchange for participating in a €110 billion ($158.6 billion) bailout for Greece, raising concerns that the Mediterranean nation may default.

Markets have grown more worried about the potential for a Greek debt default amid an apparent lack of progress in resolving the collateral issue this week. Finland, meanwhile, shows no sign of backing down.

Also Thursday, German Chancellor Angela Merkel unexpectedly canceled a trip to Russia in early September to shepherd through parliament a crucial change to the euro-zone bailout fund.

The cancellation comes at a sensitive time for relations with Russia, and amid growing nervousness about dissent within the ranks of her own party over her handling of the euro-zone debt crisis.

"The date collides with the introduction of the [European Financial Stability Facility] treaty into the Bundestag," a German government official said Thursday, adding that the chancellor wants to stay in Berlin due to the significance of the issue.

Thursday, August 25, 2011

German Chancellor Angela Merkel has withstood the pressure from southern Europe: there will be no Eurobonds. For the markets, this is a disappointment, but there is no other way for these countries to rebuild themselves than to insist patiently on a phase of debt discipline and an end to lax budget constraints.

Investors in Europe’s troubled economies are already getting enough as it is. Eurozone leaders’ decision on July 21 to allow the European Financial Stability Facility to buy back old debts – limited only by the EFSF’s capacity – already amounts to a type of Eurobond. And the European Central Bank will also blithely continue its bailout policy in terms of giving loans to the eurozone’s troubled members and purchasing their government bonds.

Southern Europe, however, is pushing hard for a complete changeover to Eurobonds to get rid of the interest-rate premiums relative to Germany that markets are demanding of them. This is understandable, given that the hope of interest-rate convergence was a decisive reason for these countries to join the euro in the first place. And, for a little more than a decade, from 1997-2007, this hope was realized.

The €109bn second bail-out for Greece is practically dead on arrival. The dispute between Finland and other eurozone member states over its collateral deal with Athens is the latest setback. The package is already undermined by the limited scope of private sector participation, while Greece is groaning under the burden of meeting its fiscal targets. Even if the Finnish dispute is resolved, the package will not prevent a default by Greece: two-year Greek bonds now yield 46 per cent.

The bail-out package has one overriding flaw – it was designed more to help European banks maintain the fiction that their exposure to Greece was secure than to provide relief for Athens. Even bankers, however, are coming around to the view that the centre cannot hold and are starting to write down their Greek exposure. The collateral dispute may hasten that trend by driving a coach and horses through the convention that new debt does not take priority over existing debt.
More

Wednesday, August 24, 2011

The European common currency is in trouble, several EU countries are facing mountains of debt and solidarity within the bloc is declining. It is European youth, in particular, who have drawn the short stick. Closer cooperation is the only way forward.

Germany's European policy is about to undergo a transformation as significant as Ostpolitik --the country's improvement of relations with the Soviet bloc -- was in the early 1970s. While that policy was characterized by the slogan "change through rapprochement," Berlin's new approach might be dubbed "more justice through more Europe."

In both cases, it is a question of overcoming a divide, between the East and the West in the 1970s and between north and south today . Politicians tirelessly insist that Europe is a community of fate. It has been that way since the establishment of the European Union. The EU is an idea that grew out of the physical and moral devastation following World War II. Ostpolitik was an idea devoted to defusing the Cold War and perforating the Iron Curtain.

Unlike earlier nations and empires that celebrated their origins in myths and heroic victories, the EU is a transnational governmental institution that emerged from the agony of defeat and consternation over the Holocaust. But now that war and peace is no longer the overriding issue, what does the European community of fate signify as a new generational experience? It is the existential threat posed by the financial and euro crisis that is making Europeans realize that they do not live in Germany or France, but in Europe. For the first time, Europe's young people are experiencing their own "European fate." Better educated than ever and possessing high expectations, they are confronting a decline in the labor markets triggered by the threat of national bankruptcies and the economic crisis. Today one in five Europeans under 25 is unemployed.

German President Christian Wulff blasted the European Central Bank's policy of buying up bonds from indebted euro-zone countries on Wednesday, saying it runs counter to European Union laws. His comments highlight just how controversial efforts at propping up the common currency have become.

German President Christian Wulff on Wednesday publicly questioned the legality of the European Central Bank's program of buying bonds of debt-ridden EU countries as a way of propping up their economies.

Speaking at a conference of economists in the Bavarian town of Lindau, Wulff said: "I regard the massive acquisition of the bonds of individual states via the European Central Bank as legally questionable."

He referred to an article in the EU's fundamental treaty which bars the ECB from buying bonds directly from governments. Because of the article, the ECB has been purchasing bonds on the secondary market. The ban, Wulff said, "only makes sense if those responsible don't circumvent it with comprehensive purchases on the secondary market."

Eurobonds are being touted as the silver bullet to resolve the Eurozone crisis. This column argues that the Eurobonds proposal fails on legal, political, and economic grounds. It says that, whatever the variant, Eurobonds only make sense in a political union—and given the vast differences in national political systems and their quality of governance, any political union created on paper will not work in practice.

The term “Eurobond” is usually taken to mean a bond which has a “joint and several” guarantee by all member states of the Eurozone (see for instance Manasse 2010 and Suarez 2011). The “joint and several” guarantee implies that if the issuing country cannot service its “Eurobond” debt the creditors can demand payment from all other Eurozone countries. This would imply that in extremis the creditors could demand that Finland or Estonia pay up for the (Eurobond) debt run up by, say, Greece or Italy if the other large Eurozone members are either unwilling or unable to pay.

This contribution deals only with the idea that member states should be able to issue Eurobonds to finance their deficits and convert at least part of their outstanding debt. This is, of course, a totally different proposition from the idea that a common institution should be able to finance some task of common interest (see Gros and Micossi 2008).

Euro-zone governments are discussing a plan to have noncash Greek government assets, including real estate, offered as collateral for a new round of rescue lending to Greece, backing away from a bilateral agreement reached last week between Greece and Finland, officials said Tuesday.

The discussions come as opposition is mounting among the governments to the Finnish-Greek deal—which would see Greece pay Finland hundreds of millions of euros in cash as collateral against the loans. Crucially, German Chancellor Angela Merkel has rejected the deal, said a German lawmaker.

"It can't be that one country gets extra collateral," Ms. Merkel told parliament members of her ruling Christian Democrats, or CDU, in a meeting on European policy, the lawmaker said.

Other governments are now seeking similar deals, saying the arrangement could undermine Greece's ability to repay them.

There has been much talk about solidarity among eurozone governments as they strive to resolve their sovereign debt woes. But as leaders seek to navigate the ever narrower straits between the politically intolerable and the economically suicidal, the gap between rhetoric and action has widened.

There is little solidarity evident in the latest initiative by some creditor countries to shake down Greece for cash collateral with the aim of securing their commitments to Athens through the obligations taken on by the European financial stability facility.

True, the political pressure on creditor governments to limit their exposure to the troubled southern periphery has been mounting as the economic picture has soured. But the preferential deal Finland has struck with Athens is simply destructive of the wider objective of assisting Greece.
More

So, I return from vacation to find that the restructuring of Greece continues to be very much a work in progress. Indeed, it now appears much more likely that Lehman Brothers will confirm a Chapter 11 plan before the European Union will work out its similar issues regarding Greece, Portugal, Ireland, Italy and Spain.

The latest problem comes from Finland’s misunderstanding of the nature of a bailout.

As readers no doubt recall, Greece ratcheted up it its projected deficit – almost doubling it, in fact – after the financial crisis. That quickly lead to Greece’s inability to refinance its debts at an affordable rate in the markets, and several rounds of bailout financing by the European Union and International Monetary Fund began. In exchange for such financing, Greece agreed to extremely painful austerity measures.

Tuesday, August 23, 2011

The rich countries of the northern euro zone are bearing the brunt of bailing out their debt-stricken fellow members. Resentment is growing among their populations, helping euroskeptic right-wing populists to win support. But there is little awareness of how much the European Union has done for their own countries.

Officially, of course, the one-euro coin is worth the same everywhere. But given the current state of the euro zone, you could be forgiven for thinking that the coin with the Greek owl or Spanish king on its reverse is worth less than one bearing, say, a German eagle or the silhouette of the Netherlands' Queen Beatrix.

An invisible crack now divides the euro zone. With their triple-A rating from the American credit rating agencies, six of the euro zone's 17 member states are considered sound borrowers. And the more government finances in Greece, Portugal, Italy, Spain and Ireland are thrown out of kilter, the more the countries with the best credit ratings are expected to vouch for the euro. They include, in addition to Germany and France, Finland, Luxembourg, the Netherlands and Austria.

From the Austrians eating at sausage stands in Vienna to the regulars at fish stalls in The Hague, to Luxembourg bankers and Finnish businesspeople, many in the euro zone's model countries seem conflicted nowadays. They are torn between the strong suspicion that some of their hard work is going down the drain with the hundreds of billions that are currently disappearing into aid packages and bailout funds for threatened EU countries, and the hope that their political leaders, in their efforts to appease citizens, might be right after all.

This euro crisis is not only about rescuing a common currency. It's about fundamental questions of political union.

It's about the suspicions of many Europeans that people in the southern part of the EU, derisively referred to as the "olive zone," lived well at the expense of others, and that those who were more careful with their money are now expected to swallow the poison that is making its way northward. On the other hand, it is not clear whether the EU will be able to continue in its current form if some countries are effectively under receivership while the strong economies are in a position to call the shots in future. Is there a threat that Germany, the economic giant among the triple-A countries, could unintentionally become the leading power in Europe through its fiscal authority?

Chancellor Angela Merkel will meet conservative parliamentarians on Tuesday evening to try to allay their concerns about her management of the euro crisis. Many are unhappy about the EU deal to increase the scope of the bailout fund -- and are dissatisfied with Merkel's leadership style.

Many in Chancellor Angela Merkel's conservative Christian Democratic Union party are unhappy about Germany's growing commitment to euro bailout packages and fear that the nation is being locked into a "transfer union" in which German taxpayers will end up bankrolling high-debt nations that got themselves into trouble through their own profligacy.

The dissatisfaction is dangerous for the chancellor because it could put her parliamentary majority at risk in a crucial September vote on the July 21 agreement by euro zone leaders to widen the scope of the €440 billion ($637 billion) euro rescue fund.

Klaus-Peter Wilsch, a member of parliament for the CDU, is among the most vocal critics of Merkel's euro policy, and says dozens of fellow MPs feel the same way. "I know from personal conversations that there is great dissatisfaction among 30 to 40 conservative MPs," he says.

Wilsch has said he will vote against the new euro measures because the increased powers being assigned to the European Financial Stability Facility (EFSF) would be a step towards introducing euro bonds.

Merkel will try to calm nerves on Tuesday night when she meets with conservative parliamentarians to woo their support for the legislation. She has repeatedly made clear in recent weeks that she is opposed to euro bonds, which some senior EU officials and high-debt countries including Italy have been calling for as a way to stabilize debt markets.

Greek households and small businesses show growing signs of strain as knock-on effects of government cutbacks ripple through the country's fragile economy.

Greeks like Maria Tergi speak of how cuts are eroding livelihoods and social structures. She felt compelled to shut down her lottery shop on Athens's busy Omonia square after 50 years because tight funding closed a drug rehabilitation center nearby, sending drug addicts out on the street outside her door.

"My customers play 70% less money because of the crisis, the landlord kept on asking higher rent and now this," she says when closing down her shop for the last time. "It has never been this bad. I can't cover the running costs so I am closing down."

Across town, Efi Panagou owns three small apartments and two shops. The income from the rents gave her a decent living but her tenants have stopped paying since February, even as the government raises her property taxes.

"The tenants come to me crying, saying that if they pay rent they won't be able to pay for utilities and food—it breaks my heart," she says. "The government has no sense of reality. They only know to talk numbers."

Monday, August 22, 2011

The Eurozone crisis is accelerating dangerously, bringing us to the brink of what would be history’s biggest ever financial rout. The spectre of the 1930s, including competitive devaluations and Eurozone break up, is getting dangerously relevant. This revised column argues that last week’s policy changes are not sufficient. Getting ahead of the crisis will require a guarantee for the entire stock of Eurozone debt – either by the ECB, or via some sort of Eurobond scheme.

In this crisis, Eurozone leaders’ motto seems to be “too little too late”.

They got it badly wrong the first weekend in May 2010.

Having announced that they had saved Greece, financial markets said “not good enough”. The next weekend they came up with a more substantial plan, but even this proved to be too little too late.

After months of living in denial, Eurozone leaders finally recognised that Greece was not going to be able to restart borrowing on its own. They came up with another plan. On 21 July 2011, they got it badly wrong again. Financial markets are again said “not good enough”.

On August 16 Chancellor Merkel and President Sarkozy held a widely-trumpeted “summit” to announce decisions that were either irrelevant or misguided. Stock markets around the world said “not good enough”. Even more ominously, the interbank market is seizing up, as it did in 2007 on the way to the Lehman disaster.

The EU's attempts to deal with the financial crisis by imposing austerity on member states will further alienate voters already disenchanted at the lack of accountability in Brussels and Frankfurt, leading European politicians and union leaders have warned.

In a succession of interventions aimed at appeasing markets and shoring up the balance sheets of eurozone countries, the European Central Bank (ECB) has demanded austerity policies in Greece, Portugal, Ireland and Italy, in the latter case even telling Silvio Berlusconi which measures must be instituted when and how. The Italian prime minister acquiesced, complaining that his administration was being made to look like "an occupied government".

Antonio Di Pietro, a leading liberal MP, said: "Italy is under the tutelage of the EU, and a country under tutelage is not a free and democratic one."

With alarming speed, Europe’s debt crisis has spread this summer from small countries such as Greece on the rim of the single-currency area to large economies such as Italy at its heart. The European Central Bank (ECB) has restored calm in Italian and Spanish government-bond markets for the moment by making big purchases of their debt. But such bond-buying is a temporary palliative. Many are now calling for a more fundamental solution to the crisis: the issue of “Eurobonds” in order to provide a fiscal underpinning to the shaky monetary union.

These Eurobonds are not to be confused with their namesakes invented in the early 1960s, when bankers severed the link between currency and country of issuance by helping international borrowers sell dollar-denominated bonds in London. What advocates of new-style Eurobonds have in mind for the euro area would be even more far-reaching: they wish to sever the link between the creditworthiness of a country and its cost of borrowing. The 17 member states of the single-currency area would be able to borrow in bonds issued by a European debt agency. These would be jointly guaranteed by all euro-area countries and thus underwritten in particular by the most creditworthy of them—above all, Germany, because of its economic clout and top-notch credit rating.

An underlying rationale for Eurobonds is that the public finances of the euro area as a whole look quite respectable, at least compared with those of other big rich economies. The IMF envisages that general government debt will reach 88% of the single-currency zone’s GDP this year. This is lower than America’s 98% and not much higher than Britain’s 83%. The euro area’s projected budget deficit will be a bit above 4% of GDP, better than America’s 10% and Britain’s 8.5%. Neither America—despite the recent downgrade of its debt by a rating agency—nor Britain has been subject to a debilitating loss of confidence. This suggests that pooling debt could indeed put an end to the euro crisis.

Saturday, August 20, 2011

Allowing deeply indebted European countries the chance to restructure their obligations seems to be the most direct approach to resolving the problem, yet has been met with resistance that likely will only prolong the crisis.

The reason: What once was thought to be a minor problem involving only some smaller peripheral nations in the European Union is now increasingly being recognized as a global train wreck about to happen.

"The problem in Europe is that the banking and national interests have been uncommonly incestuous over the years with banks in France owning the debts of companies in Spain and Spanish sovereign debt, while the banks in Spain own the debts of French companies and the French sovereign," Dennis Gartman, hedge fund manager and author of The Gartman Letter, wrote Friday. "In that environment, as one area of the economy contracts, others do also in a rush to liquidity and to the detriment of all."

The eurozone debt dilemma has been one of the root causes of market turmoil over the past two months, even though the problems have been known since at least early 2010.
More

Other Blogs by Aristides Hatzis

Subscribe to "The Greek Crisis"

Search This Blog

by Petar Pismestrovic

About

This blog is dedicated to the understanding of the current Greek (but also European) economic, political and institutional crisis. It was created by Prof. Aristides Hatzis of the University of Athens, after many requests by his students who seek a source of reliable analysis on the Greek current affairs. Its aim is to post commentary and reports published mainly in the major U.S. and European media and to encourage a rigorous discussion.